Chapter 29 - Aggregate Expenditures Model

Assume Prices Are Fixed

-price level won’t change

-stopped production rather than dropped prices

Assume GDP = DI

-until government is added

Excess Capacity

-we can raise output without raising price level

Dictated by C + Ig

-stays constant at the current real interest rate

-consumption schedule —> C + Ig

Real Domestic Output

-amount output firms are willing to produce as long as their costs are covered or exceeded

Aggregate Expenditures

-C + Ig

-amounts planned to be spent in a private closed economy

Equilibrium GDP

-spending = output

-C + Ig = GDP

-no overproduction

-no excess spending

-changes in response to a change in C or Ig

Spending GREATER than GDP

-production, employment, wages UP until equilibrium is achieved

Spending LESS than GDP

-production, employment, wages DOWN

Savings

= planned investment

-leakage

-money not spent on consumption

Investment

-injection

-replacement for consumption

Savings > Investment

-C + Ig below 45 line

-production, employment, income DOWN

-people dip into savings

Savings < Investment

-C + Ig above 45 line

-production, employment, income UP

-people save more

Unplanned Changes

-help get back to equilibrium

-planned changed are part of Ig

Spending > Production

-unplanned REDUCTION of inventory

-more profit = more production

Spending < Production

-unplanned INCREASE in inventory

-less profit = less production

GDP Gap

= amount spent * spending multiplier

Tax Multiplier

- = MPC / MPS = x

-Gap / x = cut taxes

Spending = Income for Someone Else

-a change in C + Ig has a greater effect than the initial change

-increase = MORE income for many people = larger INCREASE as each INCREASES spending

-decrease = DECREASING income for many people = larger DECREASE as each DECREASES spending (use multiplier!!)

Exports

-made in USA and sent abroad

-included in aggregate expenditures

Imports

-created abroad

-subtracted out

Positive Net Exports

-INCREASES aggregate expenditures and equilibrium GDP

Negative Net Exports

-DECREASES aggregate expenditures and equilibrium GDP

-use multiplier

Prosperity Abroad

-people abroad have MORE money = buy MORE american goods

-income abroad DOWN = buy LESS American goods

-GDP + Xn drop

Exchange Rates

-dollar value DROPS = american goods CHEAPER = GDP + Xn UP

-dollar value RISES = american goods more EXPENSIVE = GDP + Xn DOWN

Tariffs and Devaluations

-RAISE Xn

-cause world-wide issues

Adding to the Public Sector

-assume gov spending is INDEPENDENT of output

-assume only personal taxes

-assume taxes are a fixed amount

Government Purchases and Equilibrium GDP

-gov spending pushes aggregate expenditures UP

-use multiplier

Taxation & Equilibrium GDP

-lump-sum tax = amount, not rate

-taxes REDUCE disposable income

-lowers BOTH consumption and savings

-use MPC & MPS

-will DROP GDP

Differential Impacts

-changing government spending has a larger impact than changing taxes

-G is a direct injection

-taxes are dependent on MPC to change C

Recessionary Gap

-usually due to unemployment

-amount by which aggregate expenditures at full employment GDP FALL SHORT of those required to achieve full-employment GDP gap

-fall in output (GDP) = GDP gap * multiplier

Keynes’s Solution to a Recessionary Expenditure Gap

-increase government spending by using spending multiplier (1/MPS)

Keynes’s Solution to a Recessionary Expenditure Gap - DECREASE taxes

-increases disposable income

-figure out change in C = tax cut * MPC

-use tax multiplier (MPC/MPS)

Keynes’s Solution to a Recessionary Expenditure Gap - WARNINGS

-prices RISE as economy moves CLOSER to POTENTIAL GDP

-not stuck prices

Inflationary Expenditures Gap

-amount by which an economy’s aggregate expenditures at the full employment GDP EXCEED those required to achieve full employment GDP

-sustaining equilibrium ABOVE full-employment GDP is IMPOSSIBLE

Inflationary Expenditures Gap - What Happens?

-economy produces AT or JUST ABOVE potential GDP

-demand pull inflation

-nominal GDP goes UP but real GDP does NOT